This week I attended a webinar organised by PwC with a UK global economic update delivered by Dr Andrew Sentance CBE, Senior Adviser with Cambridge Econometrics and a former member of the Bank of England Monetary Policy Committee. Dr Sentance is undoubtedly one of our leading economists and I have attended a number of similar seminars in the past but never one at such a time of economic turmoil. Dr Sentence set out to describe the massive hit to the UK global economy in 2020; to consider prospects for recovery in 2021 and beyond; to outline the monetary and fiscal policy options open to the Bank of England and the Treasury; and to describe the “new normal” that we can expect in the medium term.
The global downturn in 2020 in world GDP has been the sharpest in recent memory. Indeed the fall in UK GDP is the largest since 1720. The Bank of England historical database shows that previous large falls were experienced in the years 1919 to 1921 at about 8% per year or 25% over the three-year period. This not only coincided with the end of the First World War but also with the previous large pandemic known as Spanish flu. Prior to that large falls were experienced as long ago as 1826 and 1728 but Her Majesty’s Treasury review of independent forecasts suggests that in 2020 the fall in UK GDP will have been more than 10%. The fall in GDP in the year to quarter three i.e. after the rebound from lockdowns contrasts unfavourably with other major economies. The US is just over 2%, Germany, France, Italy and the Euro area in general are around 4%, Spain is just over 8%.
However, part of this difference is explained by the fact that the UK calculates GDP in a more puritan way. While most countries simply measure public sector economic output as its cost, the Office for National Statistics (ONS) reacting to the very large amounts of money Gordon Brown was pumping into public services back in 1997, which simply meant that the more he spent the more GDP rose, decided that this made no allowance for quality. To reflect productivity better the ONS began to base public sector output on a basket of measures including elective operations and teaching hours. International bodies urged other OECD nations to do likewise but it seems that few bothered. However, Dr Sentance believes that the difference is probably only of the order of 1 to 2% which would suggest that in any event UK was hit more than almost all other major economies.
The second and third lockdowns that have since taken place will undoubtedly drive double-dip recession. There are very large sectoral variations in the UK downturn. While public administration etc grew with additional public spending and retail and wholesale, while including very large number of retailers in difficulties, others benefitted so overall the sector was flat. The most badly affected has been hospitality with a decline of 30% in gross value added output in the year to October 2020 and service activities such as hairdressing were down 25%; the arts and entertainment and administrative support services over 20%; health and social work despite apparent increases in demand were also down nearly 20%; transportation and storage again despite the increasing online shopping down nearly 15% with so many people working from home. Education, professional scientific and technical work in information and communication were down around 10%; construction and manufacturing about 7%; finance and insurance had a small decline. It is unusual to see such variations in a recession where normally the impact is spread more evenly.
Such variations also affected employment with increases in health and social work public administration, maintenance of status quo in education, small declines in finance and insurance, construction and transport and storage, but very significant reductions in payroll numbers in the arts entertainment and hospitality.
Dr Sentance was a member of the PwC team that prior to the 2016 referendum made an estimate of the impact Brexit would have on the economy. He showed that the actual effect was quite close to their scenario but slightly better than expected but that of course the coronavirus had a very significant impact versus both the previous trend and the scenario that they had developed. According to the IMF World Economic Outlook as of October 2020 together with PwC forecasts the decline in real GDP would have been greater in the UK than in the rest of the euro area or the US but the recovery should be quite similar or even better in the UK. However, this may be misleading as the lost business will not be recovered. What we mean by recovery is that the economy will get back to its former level but will have not recovered the consumption that has been impacted by the coronavirus.
The IMF World Economic Outlook suggests that the medium term economic prospects out to 2025 are best in the major economies in the US, Canada and France with the UK a little behind, but ahead of Germany, Italy and Japan.
Dr Sentance likes to look back over the two centuries that the Bank of England has been tracking the annual change in GDP. The ONS took over this responsibility in 1950, the year of my birth and when looked at year by year the historical average percentage change is 2.12%. The worst decade in these 200 years were the 1920s incorrectly recalled as “the roaring 20s” There may have been a behavioural change with people letting their hair down following the deprivations of the First World War but in economic terms the growth was even lower than in the 1900s and 1910s. Undoubtedly the Spanish flu pandemic had a major impact on this. The best years of growth were the 1950s and 1960s but, of course, that was also in correction of the very slow rates of growth during the war years and in the 1930s. Even in the 1970s and 1980s, despite the problems with the oil price and poor industrial relations, UK growth averaged 2.6%. This slowed to 2.2% in 1990s in line with the historical average, then slowed again in the 2000s and 2010s to below 2% but Dr Sentance forecasts that in the 2020s it will slow even further to 1.3%.
Surprisingly Dr Sentance does not show the impact of population growth in these numbers. To my mind we should always look at GDP per capita rather than simple GDP as the population of the United Kingdom has increased significantly over this period. Therefore these low rates of growth in the last 20 years or so are even worse when expressed as GDP per capita; indeed there may have been no growth at all.
Dr Sentance believes that the unemployment downward spike experienced in 2020 should be short lived when looked across the G-7. My own view is that will not be the case in the UK where I think we are going to see levels of unemployment that we have not seen since the 1980s.
Unsurprisingly IMF World Economic Outlook combined with PwC forecasts going out to 2050 suggest that the Asia-Pacific percentage share of world GDP is going to grow very significantly with corresponding declines in share in both North America and in Europe. China is set to overtake the United States as the largest economy in the next few years but again when looked at on a per capita basis China is a very small economy. But as an authoritarian state it can choose to spend on nuclear weapons and extending its soft power through the world rather than in looking after its own people.
In the 2020s global growth will be driven by demographics, technology, trade and investment policies, and the challenge of climate change. These drivers have been described by Dr Sentance in previous years, but this year he chose to add a new one - that of international cooperation on health and science and I think this is both shrewd and also welcome.
Dr Sentence is a confirmed Remainer and gave a fairly downbeat view of the impact of Brexit with an increase in non-tariff barriers, more regulations and paperwork related to trade with the EU. That is clearly true. Access to EU labour markets will be more restricted for UK based businesses and individuals and again that is clearly true. The UK he believes will be a less attractive location for international business due to reduced market access outside the UK, and he sees that theoretically the UK gains flexibility of business regulation but loses influence internationally via the EU. In questions afterwards I asked him if there was not at least some upside in the UK gaining the ability to negotiate new trade deals, some of which had already been completed. He felt these simply replicated existing relationships that these countries had had with the UK when it was member of the EU. I did not have the opportunity to debate this with him but he is wrong as some of these deals do improve terms and with some countries that do not have a free trade agreement with the EU.
In considering UK government debt as a percentage of GDP at the financial year end Dr Sentance again took a very long view going back to 1700 for Bank of England data with Office of Business Responsibility data and forecasts from 1989 to 2025. Historically the level of 100% which is roughly where we are today is not especially high. Indeed at the height of the Second World War it was 250%. From 1780 to 1850 it was always in excess of 100%. Even in 1958 when Harold Macmillan was telling the nation that we’ve never had it so good it was over 100%. Dr Sentance is not particularly concerned about this level of debt believing that with low interest rates and an impeccable record of paying interest and paying off its debt over time the British government is a sound institution to which lenders are happy to continue to lend money. Of course, you would change your mind if the institution were to lose that reputation.
Coming up to the March 2021 budget Dr Sentance believes that Rishi Sunak has a number of options. There is no immediate need to introduce tax rises or significant spending cuts. It would be sensible to set out a strategy for reducing the deficit over the medium term. The national debt does not need to be paid off – it just needs to be well managed. And if there are going to be any tax rises they should be linked to tax reform. Similarly government spending restraint should be linked to public services reform. However, Dr Sentance does not have full confidence that the present administration would be able to deliver on this.
As a former member of the Bank of England MPC Dr Sentance has some concerns about its present membership. At 0.1% interest rates are near zero and he believes that quantitative easing is simply maxed out as a strategy. Negative interest rates would be more damaging than helpful and I completely agree, I think there has to be an interest. The new governor Andrew Bailey and the current members of the MPC are sending mixed messages and he suggests, perhaps tongue in cheek, that it might be time to put the MPC on furlough.
Is there a “new normal” emerging through the fog? Well there is increasing interest in policy support for the green agenda. It’s clearly established that homeworking is a longer term option and that perhaps we are seeing the death of the office or at least its transformation. It is clear that more business is taking place online and that is unlikely to change. Health is becoming a stronger driver for perception of well-being. There is now greater emphasis on soft capital (health, education etc) versus hard Investment and even though the UK economy is already primarily focused on services that is still increasing as a proportion and to support all of these above trends, taxation and government grants and aid need to be much better geared.
Overall in summary what does he think of the business and political implications of this? The UK and other major economies will recover from a virus but more slowly than some people think. The UK government’s thinking is still very short-term focused, so positive long-term strategic views are unlikely to drive policy responses. Internationally, the business and political environment is improving with the prospects of the Biden administration. But rogue states and threats remain with Russia, Iran, North Korea, and the rest. Nothing has been done by President Trump to curb their activities. China remains strong, and is still the main rival superpower to the US. China needs to be linked more firmly into the global political infrastructure to match its business influence. Europe does need to reinvent itself, but sadly for Dr Sentance the UK has passed up on contributing to that project by leaving the EU.
Overall I think Dr Sentance makes a good and interesting summary of the economic outlook though, of course, when he made his presentation a year ago he got everything wrong as he did not foresee the effects of a pandemic.